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Bad bonds, late bills among DWSD problems

43The percentage of Michigan residents — in more than 120 communities and covering 1,079 square miles — who live in the area served by the Detroit Water and Sewerage Department

50Roughly the percentage of total customer accounts that are delinquent, including residences and some large municipalities and organizations such as Detroit Public Schools

$142.5The amount, in millions, of the total unpaid balance from delinquent accounts of residents and businesses in the city of Detroit

Can federal mediators, or the state, help broker a deal to create a regional water authority for Southeast Michigan?

U.S. District Judge Sean Cox held separate meetings with negotiators for Oakland, Macomb and Wayne counties last week. Detroit officials expect to have their own mediator meeting this week.

The talks, court-ordered mediation as part of bankruptcy proceedings, are confidential.

But suburban concerns have been aired long before U.S. Bankruptcy Judge Steven Rhodes made the April 17 mediation order.

"No deal is better than a bad deal," Oakland County Executive L. Brooks Patterson said in marketing materials.

Crain's reviewed hundreds of pages of documents and interviewed a half-dozen suburban leaders to identify the chief concerns over a proposed 40-year deal for a new regional Great Lakes Water Authority to manage the Detroit Water and Sewerage Department.

Some highlights: The system's bonds are now junk status, its infrastructure is in tatters and it's shipping about 50 percent of the city consumer water that flowed just 15 years ago.

Both Patterson and Macomb County Executive Mark Hackel believe the proposed regional authority plan is constructed more to funnel operating cash to Detroit than it is to run, improve and manage the water operations that require millions of dollars in investment.

Emergency Manager Kevyn Orr, meanwhile, contends a regional authority is the best scenario in Detroit's restructuring efforts, but he'll consider others if he must.

Here are nine of the talking points on regional water — and the difficulties in resolving them — that will likely resurface in mediation:

Rate structure not sustainable

RATES

An average 4 percent increase among suburban communities can't cover the investment and repairs the system needs. Oakland County contends that the water department needs to raise rates an additional 13.3 percent for the water fund and 23.2 percent in the sewer fund to eliminate those funds' operating losses.

When the water department's regional Board of Water Commissioners voted in March on a proposed 4 percent increase for water and sewer billing rates for the fiscal year starting July 1, only Oakland County board representative and Dickinson Wright PLLC partner J. Bryan Williams voted "no."

A chief suburban assertion: Detroit's rate structure is flawed.

An average 4 percent increase among suburban communities can't cover the investment and repairs the system needs, says Oakland County Water Resources Commissioner Jim Nash.

Oakland County claims DWSD needs to raise rates another 13.3 percent for the water fund and 23.2 percent in the sewer fund to eliminate those funds' operating losses.

Meanwhile, after talks broke down in March, the city put out a request for information to private companies interested in taking over DWSD operations, asking for bids that keep rate increases at or below 4 percent through 2023.

The counties are concerned that either scenario isn't workable long-term. Both Oakland and Macomb officials have said the rate structures wouldn't cover DWSD's ongoing budget deficits without exorbitant future rate hikes.

Delinquencies

DELINQUENCIES

In addition to delinquencies in residential accounts, more than $20 million is past due on city commercial and industrial accounts, $3.8 million was owed by the Detroit Public Schools, more than $200,000 was owed by Wayne State University and more than $6 million was owed on municipal accounts.

Too many Detroit residents and businesses aren't paying their bills. Or aren't around to pay their bills.

As of Feb. 3, Detroit carried about a $142.5 million total unpaid balance from delinquent business and residential accounts within the city limits — including nearly $112 million more than 60 days past due. About 153,200 of the 162,400 delinquent accounts are city residential properties, accounting for just over half the unpaid sum, according to an accounts receivable report from Deputy Director Darryl Latimer.

How much of the residential delinquents are due to abandoned properties? About 70,000 homes — or nearly 20 percent of the city's housing inventory — are believed to be abandoned.

DWSD policy is to shut off water service when bills are 45 days past due. So tens of thousands of those accounts could represent vacant homes that are no longer connected to the system, and a majority of residential balances are 180 days old or more, according to the report. Orr has said in the past that Detroit was losing an average 24,000 residents per year between 2000 and 2010.

Suburban negotiators have discussed using public assistance programs to make water payments on behalf of low-income city families to reduce unpaid bills. One option: The state Housing Choice Voucher program that makes direct payments to landlords of low-income tenants could also make direct payments for water. Or state income taxpayers could make an optional contribution to nonprofits, like The Heat and Warmth Fund, that help cover such bills. But the state would have to administer such a payment program, and is not currently part of the authority talks.

In addition to the residential delinquencies, more than $20 million is past due on city commercial and industrial accounts, another $3.8 million was owed by Detroit Public Schools, more than $200,000 was owed by Wayne State University and more than $6 million was owed on municipal accounts.

$1 billion in lost value

ASSETS

Interest expenses, investment losses and other nonoperating costs have put water and sewer funds into the red. In June 2008, financial statements showed combined net assets of $1.05 billion; by mid-2013, those assets had dropped to just $20 million. Net assets, a measure of equity, could affect DWSD's future ability to borrow money either for the department or for a future authority, particularly since the department already carries more than $5.5 billion in bond debt.

Interest expenses, investment losses and other non-operating costs have put the city's water and sewer funds into the red. In June 2008, financial statements showed combined net assets of $1.05 billion; by mid-2013, those assets had dropped to just $20 million.

Net assets, a measure of equity, could affect DWSD's future ability to borrow money either for the department or for a future authority, particularly since the department already carries more than $5.5 billion in bond debt.

The city computes net assets by weighing revenues, property, cash in liquid accounts and other assets against interest, depreciation and other liabilities — though it does not include unfunded pension liability or retiree health costs.

The department's bond debt would be redeemed or refinanced under the city's adjustment plan in bankruptcy court, presumably at better interest rates that yield some savings and improve the balance sheet.

But the department has racked up $1.5 billion in such losses over the past seven years and its bond rating is in junk territory. Fitch Ratings Ltd. recently downgraded its rating on some DWSD bonds to BB+ while Standard & Poor's has given the department a CCC bond rating, both with a negative outlook.

The city also had about $11.1 million of unreserved cash and about $50 million in balances owed to vendors at the end of fiscal 2013, according to a draft financial statement.

Optimistic budgeting

BUDGETING

An income statement projection for 2014 calls for the department to increase net assets by $13.7 million — even though net assets were depleted by a combined $147 million the preceding year — between the department's water and sewer funds.

All of this may be why Macomb County officials think Detroit's amended plan of adjustment filed March 31 in bankruptcy court is too optimistic in its projections for the current fiscal year.

An income statement projection for 2014 calls for the department to increase its net assets by $13.7 million — even though net assets were depleted by a combined $147 million the preceding year — between the department's water and sewer funds. The city, in an appendix to the March 31 adjustment plan, uses that 2014 result as a base year for projecting future revenue and operating income, operating and maintenance expenses and other costs through 2023.

Macomb officials note that if 2014 budget estimates turn out to be flawed, then every future year of projections that are pegged to it as a base year are likely flawed as well. Oakland calls the expected return to asset growth this year "remarkable, or more likely, not realistic."

Orr's office declined to respond on this issue while mediation is underway.

A seat for the state?

If the state were to be a member of a new regional water authority, it could lend its own bond rating to the new authority, saving the authority millions of dollars in interest payments. Michigan has maintained a rating of AA from Fitch, AA- from Standard & Poor's and Aa2 from Moody's in recent months.

Local officials differ on the value of this, but Lansing would need to pass enabling legislation for the state to raise bonds on its behalf through the Michigan Finance Authority.

Oakland County officials have said they've tried to make a case several times for state membership and assistance since regional negotiations began last June.

Detroit's water and sewer system covers a 1,079 square-mile water service area covering about 43 percent of the state population in more than 120 communities, which Oakland contends gives the state a compelling interest to take part in its oversight.

But the Michigan Department of Treasury has been noncommittal on that proposal, officials said; Orr's request for a $350 million state contribution to shore up city retiree pensions may be divisive enough in Lansing this coming week, without adding another legislative request.

Terry Stanton, public information officer for Treasury, said he was unaware of any discussions on state involvement on the authority.

Bond rating pipe dreams

BOND RATING

Suburban negotiators note that the interest rate behind Detroit's capital program financing is about 4.63 percent, suggesting a postbankruptcy bond rating of an A+ or possibly AA-. That's a far cry from the deep-junk bond status of today, and suburban negotiators think it could take a new regional authority years to build that kind of a rating.

Suburban negotiators also can't help noticing that the interest rate behind Detroit's capital program financing is about 4.63 percent, a rate that would suggest a post-bankruptcy bond rating of an A+ or possibly AA-. That's a far cry from the deep-junk bond status of today, and suburban negotiators think it could take a new regional authority years to build that kind of a rating.

However, suburban customers accounted for about 64.5 percent of total department revenues in fiscal 2013, according to draft financial statements from the city. Bonding for a new intergovernmental authority with less of a connection to Detroit could be a different proposition entirely.

"It does make sense that — to the degree there are additional deeper pockets in the makeup of the new governing body — from a creditor/shared obligation status that affects confidence and a willingness to lend. A lot of other factors would be tied into that," said David Tawil, co-founder and portfolio manager of New York City-based Maglan Capital, a hedge fund that invests in distressed assets including some risky government bonds.

"But that number (4.63 percent) does sound particularly aggressive or optimistic, and the regional counties are right to question it.

"Really no one could know what will happen to the authority's rating until the market has a chance to test it."

Even if investors view a regional authority differently than a city enterprise, Macomb County officials say the bond downgrades for Detroit are tied to its decision to impair or reduce the payout on water-sewer bonds under its plan of adjustment in court. And creditors, experts say, have a long memory about past sins in the bond market. So a bond rating of A or better could be years away, and some costly infrastructure repair projects might not keep that long.

The DWSD, or a post-bankruptcy authority, already must complete a new biosolids dryer facility on land across the street from its treatment plant along West Jefferson, in time to comply with new federal air quality regulations that take effect in March 2016.

The Michigan Finance Authority is expected to issue about $150 million in new bonds on DWSD's behalf in June. The bonds will finance several construction projects including the new biosolids plant, which is under contract with Massachusetts-based New England Fertilizer Co.

Pre-funding pensions

As Crain's first reported March 10, Detroit's adjustment plan calls for DWSD to make a $675 million contribution to the city's General Retirement System pension plan for retired non-uniform city employees by 2023. That's not just for its own employees, but for everyone in the pension plan.

The city's request for proposals to private sector contractors in late March also calls for any interested businesses to include a similar pre-funding contribution to GRS by 2023, or to carve out the DWSD's share of pension assets and its unfunded liabilities, in submitting their own bids.

Either way, that revenue stream is expected to help free up money in the embattled city's general fund budget for much-needed capital improvements like vehicles and new technology.

The city expects to spend $148 million on various IT upgrades, another $447 million on infrastructure and capital programs, including at least $123 million for buildings and fleet vehicles in the police, fire and recreation departments, and at least $520 million on blight removal, all by June 2023.

But if the DWSD locks in some rate stability for city residents, and shoulders general employee pensions, a post-bankruptcy authority could have limited ability to cover that budget without leaning heavily on suburban customers.

Oakland County, in an April report, estimates the elevated pension contribution alone could require a 6.2 percent rate increase, although the city's own projections suggest the increased contribution would be gradual for the first few years.

Stopping the exodus?

FALLING CONSUMPTION

The water department puts about 610 million gallons from its treatment plants into its network of pipes every day, But of that, about 63.2 million gallons ends up at metered locations for retail customers within Detroit, compared with 125.8 million gallons per day back in 1999.

Even robust rate hikes to shore up the financial statement may get offset in part by falling volumes of water consumption. A February report from Kansas-based The Foster Group LLC estimates the water flow to city retail customers (residential customers, some agencies, and some customer groups like small businesses) in the city is about half what it was 15 years ago.

The department puts about 610 million gallons from its treatment plants into its network of pipes every day, but of that, about 63.2 million gallons end up at metered locations for retail customers within Detroit, compared with 125.8 million gallons per day back in 1999.

The city in its adjustment plan assumes a decline of 6.3 percent in retail volume between next year and 2023, or less than 1 percent per year on average, while the wholesale consumption in the suburbs falls about 2 percent over the same period and sewer usage stays flat.

Flint, meanwhile, exits the DWSD system in 2017 to join the recently formed Karegnondi Water Authority, which should serve 250,000 customers in that area starting in about two years. The departure of those customers has been previously estimated to shave more than 12 percent off DWSD revenue.

Unchartered waters

For years, the DWSD has also been able to defer costly environmental improvements to comply with the federal Clean Water Act, and could continue to do so through 2017.

That's because federal guidelines allow the state to defer improvements on water system quality improvements if the upgrades would force the cost of water or sewer bills to exceed 2 percent of the median resident's income.

Since the DWSD is a city-owned system, that cap is currently pegged to 2 percent cap of a median Detroiter's income. Officials have estimated current water system cost is about 1.84 percent of that figure, and sewer costs are about 2.6 percent.

Under an authority, however, the 2 percent cap on the median Southeast Michigan income could become a very different proposition. The state could possibly help out by continuing to defer those improvements through 2022, local officials said, but after that the authority may be legally required to make some or all of them.

The question, then, could be what kind of bond rating the regional authority has by 2022. Will it have improved the system's finances enough to fund those project costs in the bond markets?

That's a tough question, and one of the possible topics of this week's round of mediation.

Detroit and the three counties also might not get the mediation table all to themselves, either.

On Friday, the Southeastern Oakland County Water Authority, which makes wholesale water purchases from DWSD for Berkley, Beverly Hills, Birmingham, Southfield, Royal Oak, Pleasant Ridge, Lathrup Village, Huntington Woods and Southfield Township, brought a request to intervene in the bankruptcy and get authorization to participate in the mediation process. The separate Western Townships Utility Authority of Canton, Northville and Plymouth townships also supports that request.

But with no date set for all parties to gather, and the state's attention turned instead toward an expected package of bills to support the city pension funding contribution this week, perhaps one seat at the mediation table will remain conspicuously empty.